Protecting Assets Under Non-Parametric Market Conditions

Protecting Assets Under Non-Parametric Market Conditions

How to invest under non-parametric market conditions! Whether we wish it or not, like it or not, we live in a world in which passenger planes disappear, buildings collapse, rockets explode, countries implode and earthquakes, tsunamis, floods and… political revolutions occur! Information acceleration allowing, financial markets react in less than a few tens of a second based on investors’ perceptions of the incidence of these events on the behavior of others. High frequency trading systems, over leveraged shadow entities, flash crashes, and stealth central bank actions, just to name a few, further compound the situation. In this “new world”, investors must cope with a whole spectrum of “unknowns”, from “known knowns” – things they know that they know – to “unknown unknowns” – things they don’t know that they don’t know!

Extreme events in finance

To make it simple, in this chapter we are not concerned so much about “Tail events” or “Black swans” – after all, aren’t they still swans? – as we are about “Charging rhinos”, “Dangling elephants” and other… “Constrictor snakes”! The sheer complexity of these situations characterising non-parametric markets is such that they are not easily amenable to mathematical analysis – deterministic and/or probabilistic models. They can only be dealt with through the development of a parsimonious and coherent set of empirically-tested heuristics, aimed at conceptualizing the market’s response, at connecting proven facts and at converting observed discrepancies into profitable investment opportunities.

Concepts for investing under non-parametric market conditions

Under such non-parametric market conditions, investors naturally become more concerned about the return of their money than about the return on their money. Protecting Assets Under Management (AUM) becomes the surest, if not the only, path to survival and growth. When markets become battlefields for bigger forces, it is critical to provide decision makers with the right concepts to understand the nature of the unknowns they face, and to arm them with “battle-tested” decision rules (heuristics) aimed at helping them design effective investment strategies.